Microsoft Takes a Page From Apple’s Book

It, too, is now melding its own software with its own hardware

By Brad Moon, InvestorPlace Contributor

For decades, Microsoft (NASDAQ:MSFT) was derisive of Apple’s (NASDAQ:AAPL) strategy of controlling both the hardware and the operating system of its computers. By sticking to the OS and applications and letting third-party hardware manufacturers sell the PCs, Windows became the dominant computing platform on the planet.

Sure, buyers of Apple’s Mac computers might have a better overall experience, but they paid a premium for it. The market spoke: Windows runs over 90% of computers.

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However, what works on the desktop has not been holding true with mobile devices, and Microsoft is sending clear signals it intends to shift toward the Apple model as mobile devices eclipse computers in what many now call the post-PC era.

Microsoft has gone this route in the past, but in limited fashion. Its Xbox video-game consoles (a clear hit) and Zune portable music players (a clear miss) are Microsoft-branded hardware running Microsoft software. Selling software alone hasn’t provided the bang it once did, so Microsoft has been languishing as Apple has gone on to become the most valuable company on the planet.

Software releases used to provide a significant boost to Microsoft’s stock price, but that effect has diminished of late. Here’s what some previous product rollouts did for MSFT shares:

  • In the three months covering the lead-up to the 2001 release of Windows XP and the first few months the operating system was being sold, Microsoft stock rose 34%.
  • Windows 7, released in 2009, saw a 9.3% stock price increase during a similar three-month period.
  • The last commercially released version of Office (Office 2010), Microsoft’s ubiquitous business productivity software, saw the stock slide 7.2%, and it’s been down 3.4% since the consumer preview release of Office 2013 in July.

Hardware (what little Microsoft has made) has never been as spectacular as the glory days of Windows and Office rollouts, but at least it continues to have a positive effect:

  • In the three-month period leading up to the 2005 Xbox 360 release and the first two months it was on sale (during the crucial holiday season), Microsoft stock gained a modest 4.6%.
  • 2007’s Zune portable music player — which aimed to go head-to-head against Apple’s iPod — netted a 5% increase between the weeks prior to launch and the first few months the product was available.
  • When the Kinect motion controller was released for the Xbox 360 in 2010, Microsoft shares were up 6.1%

Of course, not all changes in Microsoft’s share value can be directly attributed to hardware and software launches, but its product release cycle does have a definite impact. New products mean another round of upgrades for existing customers and the potential to break into a new market, both of which typically result in a post-release revenue boost.

The problem is that the surges are short-lived, and MSFT quickly drops back to the $20-$30 range, where it’s been stuck for 10 years.

With the company in a funk — what Vanity Fair called “Microsoft’s Lost Decade” in an article earlier this year — it was time to shake things up. It was increasingly apparent that the future was in mobile, and Apple had been allowed to dominate that market with the iPhone and iPad.

Both devices employ hardware that’s well designed but usually not cutting-edge in terms of specs. Competing smartphones and tablets often had more RAM, bigger displays, beefier CPUs or better battery life. Rival operating systems like Google’s (NASDAQ:GOOG) Android or Microsoft’s Windows Phone 7 had some advantages over Apple’s iOS and offered more flexibility for users.

But consumers weren’t following the computer model with mobile. They seemed to like having the hardware and operating system inextricably tied together. By controlling both the OS and the hardware, Apple delivered a superior user experience with the iPhone and iPad. The model that had failed to result in desktop domination was leading the way in mobile.

Microsoft introduced its Surface tablet in a surprise event back in June. We knew the company was developing Windows 8 as a tablet-friendly OS, but the announcement that it was bringing its own hardware to market caught many off guard. That spawned considerable debate about whether Microsoft’s relationship with its hardware partners — the companies that had helped it to dominate the desktop — would be damaged.

There have since been increasing rumors that Microsoft is fed up with the stumbling of hardware partners like Nokia (NYSE:NOK) and intends to release its own Windows Phone 8 smartphone.

Most recent (and unambiguous) is a letter Microsoft released to its shareholders on Oct. 9. In it, CEO Steve Ballmer says: “it’s important to recognize a fundamental shift underway in our business and the areas of technology that we believe will drive the greatest opportunity in the future.” He goes on to say —  in bold text, no less — “Our business: devices and services.”

There’s little room for interpretation there. Microsoft no longer sees itself as just a provider of software and services, but also as a hardware provider. Further, Ballmer wrote: “In all our work with partners and on our own devices, we will focus relentlessly on delivering delightful, seamless experiences across hardware, software and services.”

In other words, Microsoft is adopting the Apple model of integrating hardware and software to provide the best user experience. Unlike Apple, it will still allow other hardware manufacturers to make devices that can run its operating system, but for the ultimate, fully integrated experience, users will look to the Microsoft version.

By taking this path, stumbling Colossus of Redmond hopes to reverse its fortunes, claw its way back into contention in mobile and, ideally, have each future product launch result in a significant bump in its stock value that sticks.

Microsoft is gambling that the potential multiplier of combining hardware and software could take it back to the near-$60-a-share glory days instead of languishing in the $20 to $30 doldrums as it has during the past decade.

With the Surface now available for pre-order starting at $499, we’ll soon see if Microsoft’s strategic shift will pay off.

As of this writing, Brad Moon didn’t hold a position in any securities mentioned here.

Article printed from InvestorPlace Media,

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